Understanding Prospectus Types, Indoor Management, and Promoter Roles

Posted on Mar 25, 2025 in Economics and Finance

Prospectus: Types and Key Concepts

Matters to be Stated in a Prospectus (Section 26):

A prospectus may be issued by or on behalf of a public company, either concerning its formation or subsequently, or by any person engaged or interested in the formation of a public company.

Types of Prospectus

Shelf Prospectus

  1. Certain classes of companies, as regulated by the Securities and Exchange Board, may file a shelf prospectus with the Registrar during the initial securities offering. This prospectus indicates a validity period not exceeding one year, commencing from the date of the first offer. Subsequent offers within this period do not require a new prospectus.
  2. Companies using a shelf prospectus must file an information memorandum with the Registrar before each subsequent offering. This memorandum details new charges, changes in the company’s financial position since the previous offer, and other prescribed changes.

Herring Prospectus (Red Herring Prospectus)

A Red Herring Prospectus is a prospectus that lacks complete details on the quantity or price of the securities. The first page includes a disclaimer in BOLD, stating that the information is incomplete and subject to change.

  1. As per regulations, a company planning a securities offering may issue a red herring prospectus before the full prospectus.
  2. The red herring prospectus must be filed with the Registrar at least three days before the subscription list and offer open.

Abridged Prospectus

An abridged prospectus is a memorandum containing salient features of the prospectus, as specified by the Securities and Exchange Board (SEBI).

Deemed Prospectus

Section 25 states that any document offering shares or debentures for sale to the public is treated as a prospectus. This document invites the public to purchase shares through intermediaries like issuing houses or merchant banks.

Doctrine of Indoor Management

The doctrine of indoor management protects outsiders dealing with a company. It contrasts with constructive notice, which protects the company. Constructive notice applies to the company’s external position, while the doctrine of indoor management addresses the company’s internal operations. If a contract aligns with public documents, the contracting party is not prejudiced by internal irregularities.

Exceptions to the Doctrine of Indoor Management

  1. Knowledge of Irregularity: The doctrine does not apply if the affected party knew of the irregularity, such as when the contracting person was involved in the internal procedure.
  2. Forgery: The doctrine does not cover forgery, as forgery is void from the beginning (ab initio).

Promoter of a Company and Their Legal Position

A promoter is neither a trustee nor an agent of the company because the company does not yet exist. They hold a fiduciary position towards the company being formed. Promoters have the power to shape the company’s creation and operation.

From this fiduciary position, two key results follow:

  1. Promoters cannot make secret profits. Any secret profit obtained in a company transaction must be refunded to the company.
  2. Promoters cannot profit from selling their property to the company without full disclosure. Without full disclosure, the company can either cancel the sale or affirm the contract and recover the profit made by the promoter.

Rights of a Promoter

  1. Right of indemnity
  2. Right to receive legitimate preliminary expenses
  3. Right to receive remuneration

Duties of a Promoter

  1. To disclose secret profits
  2. To disclose all material facts
  3. To make good to the company what they obtained as trustee
  4. Duty to disclose private arrangements
  5. Duty of promoter against future allottees

Liabilities of a Promoter

  1. Liability to account for profit
  2. Liability for misstatements in the prospectus
  3. Personal liability
  4. Liability at the time of winding up the company

Role of Promoters in Company Incorporation

A promoter originates the idea for forming a company and gives it practical shape using their resources and those of others. Signing the Memorandum or providing formation expenses alone does not qualify someone as a promoter. Promoters provide a valuable service in forming the company and are considered creators of wealth. However, they bear considerable risk if the idea fails.

Functions of a Promoter

  1. To conceive an idea of forming a company and explore its possibilities.
  2. To conduct necessary negotiations for purchasing a business, if applicable, potentially with expert assistance.
  3. To gather the required number of individuals (seven for a public company, two for a private company) to sign the Memorandum and Articles of Association and agree to serve as the first directors.
  4. To decide on the following:
    • The name of the Company
    • The location of its registered office
    • The amount and form of its share capital
    • The brokers or underwriters for capital issue, if necessary
    • The bankers
    • The auditors
    • The legal advisors
  5. To have the Memorandum of Association (M/A) and Articles of Association (A/A) drafted and printed.
  6. To make preliminary contracts with vendors, underwriters, etc.
  7. To arrange for the preparation, filing, advertisement, and issue of capital for the prospectus.